Kao Fong Machinery (GTSM:4510) Is Carrying A Fair Bit Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Kao Fong Machinery Co., Ltd (GTSM:4510) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Kao Fong Machinery

What Is Kao Fong Machinery's Debt?

You can click the graphic below for the historical numbers, but it shows that Kao Fong Machinery had NT$1.51b of debt in September 2020, down from NT$1.68b, one year before. However, because it has a cash reserve of NT$1.04b, its net debt is less, at about NT$465.7m.

A Look At Kao Fong Machinery's Liabilities

The latest balance sheet data shows that Kao Fong Machinery had liabilities of NT$1.28b due within a year, and liabilities of NT$934.0m falling due after that. Offsetting this, it had NT$1.04b in cash and NT$532.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$633.9m.

While this might seem like a lot, it is not so bad since Kao Fong Machinery has a market capitalization of NT$1.28b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. There's no doubt that we learn most about debt from the balance sheet. But it is Kao Fong Machinery's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Kao Fong Machinery made a loss at the EBIT level, and saw its revenue drop to NT$1.6b, which is a fall of 20%. That's not what we would hope to see.

Caveat Emptor

While Kao Fong Machinery's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at NT$48m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of NT$26m into a profit. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Kao Fong Machinery (1 is a bit unpleasant) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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